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CHAPTER 10
Keynesian Macroeconomics and Economic Instability: A
Critique of the Self-Regulating Economy

Chapter 9 introduced the idea of a self-regulating economy. According to classical economists,

the economy can move back to its long-run equilibrium without direct government intervention in
the market. Some economists take the opposite point of view: the economy is inherently
unstable and not self-regulating. Chapter 10 looks at the Keynesian approach to the economy.
The chapter both critiques the concept of the self-regulating economy and introduces the simple
Keynesian model and the concepts of the consumption function, the marginal propensity to
consume and save, and the multiplier. The simple Keynesian model is analyzed both in terms of
the aggregate demand and aggregate supply framework, and in terms of the total expenditure-
total production (TE-TP) framework to explain how the economy adjusts to disequilibrium and
why the economy may be unable to get out of a recessionary gap by itself.

 KEY IDEAS
1. John Maynard Keynes challenged all four of the beliefs on which the classical position of
the economy was based, concluding that the economy could get stuck in a recessionary
gap.
2. The simple Keynesian model is a prominent macroeconomics model.
3. The simple Keynesian model can be analyzed in terms of the aggregate demand and
aggregate supply framework, and can be used to show why Keynes believed that
government has an economic role to play.
4. The simple Keynesian model can be analyzed in terms of the TE-TP framework, and can
be used to show why Keynes believed that government has an economic role to play.

 CHAPTER OUTLINE

169
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170 Chapter 10

I. QUESTIONING THE CLASSICAL POSITION AND THE SELF-REGULATING

ECONOMY

John Maynard Keynes, the English economist, challenged all four of the beliefs on which
the classical position of the economy was based.

A. Keynes’s Criticism of Say’s Law in a Money Economy

Keynes believed that Say’s law might not hold in a money economy. He believed
that an increase in savings might not be matched by an equal increase in
investment, since both saving and investment depend on a number of factors
that may be far more influential than the interest rate. In other words, according
to Keynes, aggregate demand could fall if saving increases.

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Keynesian Macroeconomics and Economic Instability: A Critique of the Self-Regulating Economy 171

B. Keynes on Wage Rates

Keynes believed that wage rates may be inflexible in a downward direction if

employees and labor unions resist wage cuts, and that this inflexibility means
that the economy may not be self-regulating.

C. Different Markets, Different Rates of Adjustment

Not all markets adjust to their equilibrium values at the same speed. In particular,
in the labor market, the wage rate may be inflexible downward (due to long-term
labor contracts or because firms at times find it in their best interest to pay wage
rates above equilibrium levels). If wage rates are inflexible downward, then the
self-regulating properties of an economy (discussed in Chapter 9) are in
question. Specifically, an economy might get stuck in a recessionary gap

D. Keynes on Prices

Keynes believed that anticompetitive or monopolistic elements in the economy

could sometimes prevent prices from falling.

E. Is It a Question of the Time It Takes for Wages and Prices to Adjust?

Many economists today take a position somewhere between Keynes and the
classical economists. For them, the question is not whether wages and prices are
flexible downward, but how long it takes for wages and prices to adjust
downward. The classical position is that the time required before wages and
prices adjust downward is short enough to call the economy self-regulating. The
Keynesian position is that the time is long enough to say that the economy is not
self-regulating.

II. THE SIMPLE KEYNESIAN MODEL

This section identifies and discusses a few of the key components and themes of the
simple Keynesian model.

A. Assumptions

In the simple Keynesian model, the price level is assumed to be constant until
the economy reaches its full-employment level; there is no foreign sector (i.e., the
model is representative of a closed economy); and the monetary side of the
economy is excluded.

B. The Consumption Function

Keynes was particularly concerned with consumption since it is by far the largest
component of total spending. Keynes made three basic points about
consumption: consumption depends on disposable income; consumption and
disposable income move in the same direction; and when disposable income
changes, consumption changes by less. The statement specifying this

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172 Chapter 10

relationship is called the consumption function. The consumption function is

written as:

C = C0 + (MPC) (Yd), where

C is total consumption, MPC (the marginal propensity to consume) is a fraction

between 0 and 1, C0 is autonomous consumption (consumption independent of
disposable income), and Yd is disposable income. Consumption can be
increased by increases in autonomous consumption, disposable income, or the
marginal propensity to consume.

C. Consumption and Saving

Since households can only consume and save, saving is the difference between
disposable income and consumption. Disposable income can be used only for
consumption or saving, so any change to disposable income can only change
consumption or saving. It follows that the marginal propensity to consume (MPC)
plus the marginal propensity to save (MPS) must equal 1.

D. The Multiplier

According to Keynes, an increase in autonomous consumption will act as a

catalyst to additional spending, and total spending will rise by more than the
initial increase in autonomous consumption. This is called the multiplier process.
The value of the multiplier determines the total spending change. The multiplier is
equal to 1/(1 – MPC).

Just as consumption has an induced spending component, so do investment and

government purchases. The multiplier process holds for these sectors too. In
general, the change in total spending equals the multiplier times the change in
autonomous spending.

E. The Multiplier and Reality

Two important points to remember are that the multiplier takes many months to
have an effect and that idle resources must be available to be brought into
production in order for increased spending to lead to more output, rather than to
higher prices.

III. THE SIMPLE KEYNESIAN MODEL IN THE AD-AS FRAMEWORK

This section analyzes the simple Keynesian model in terms of the aggregate demand
and aggregate supply framework.

A. Shifts in the Aggregate Demand Curve

Because there is no foreign sector in the simple Keynesian model, total spending
consists of consumption, investment, and government purchases. Because there
is no monetary side of the economy, changes in any of these variables can shift
the AD curve.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Keynesian Macroeconomics and Economic Instability: A Critique of the Self-Regulating Economy 173

An increase in autonomous consumption ( CO will increase consumption (C) and

therefore shift the AD curve to the right by an amount that depends on the
multiplier.

B. The Keynesian Aggregate Supply Curve

Since the price level is assumed to be constant in the simple Keynesian model,
the Keynesian aggregate supply curve must have a horizontal section to it.

The Keynesian aggregate supply curve outlined in this chapter and implicit in the
simple Keynesian model is horizontal until Natural Real GDP, thereafter it
becomes vertical.

C. The Economy in a Recessionary Gap

Keynes believed that the private sector—consisting of the household sector and
the business sector—may not be able to move the economy out of a
recessionary gap.

D. Government’s Role in the Economy

According to Keynes, and for many Keynesians, if the private sector cannot self-
regulate the economy at its Natural Real GDP level, then maybe it is incumbent
for the government to help.

E. The Theme of the Simple Keynesian Model

This section lists the essence of the simple Keynesian model in the AD-AS
framework.

IV. THE SIMPLE KEYNESIAN MODEL IN THE TE-TP FRAMEWORK

This section analyzes the simple Keynesian model in terms of the total expenditure-total
production framework.

A. Deriving a Total Expenditures (TE) Curve

Total expenditures is the sum of consumption, investment, and government

purchases. The total expenditures curve is the sum of the components of TE.

1. Consumption

Consumption rises as Real GDP rises, but by a smaller percentage.

Consumption is drawn as an upward-sloping curve.

2. Investment

To simplify matters, we assume that investment is constant.

3. Government purchases

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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The Project Gutenberg eBook of Nothing
This ebook is for the use of anyone anywhere in the United States and
most other parts of the world at no cost and with almost no restrictions
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Title: Nothing

Author: Donald A. Wollheim

Illustrator: John B. Musacchia

Release date: October 12, 2022 [eBook #69139]

Language: English

Original publication: United States: Fictioneers, Inc, 1942

Credits: Greg Weeks, Mary Meehan and the Online Distributed

Proofreading Team at http://www.pgdp.net

*** START OF THE PROJECT GUTENBERG EBOOK NOTHING

***
NOTHING
 By Martin Pearson

[Transcriber's Note: This etext was produced from

Astonishing Stories, October 1942.
Extensive research did not uncover any evidence that
the U.S. copyright on this publication was renewed.]
The little man with the gray beard stared at me and I stared back at him.
"This is getting us nowhere," I remarked, "nowhere at all."
He nodded and sat down on the hard stone. We were trapped under the
building. The house had come down over us when the bomb landed in
the street. The rest of the tenants were probably away or dead.
Apparently only the little old man who lived on the second floor rear and
I had gotten down to the bomb-proof cellar in time. And now we were
trapped.
"We'll have to wait until they dig us out," I said. We couldn't possibly dig
our own way out. Too much blocked us in. We were buried beneath tons
of brick, rubbish and beams. They were probably busy in the street
outside, trying to rescue the people in other, less-damaged buildings.
Then again there might be fire, and the noise effectively blocked any
chance of their hearing us.
I saw him only by the light of my little pocket flash. That wouldn't last
very long. Our space was remarkably limited. This shelter had been a
part of the cellar. It had been blocked off and roofed over, but even so,
part of it fell in—the part with the supplies and stuff—the part opening
on the exit.
"Well," I said, just to say something, "what do we do now? Sit around
and wait to die?"
The little old man wrinkled his brow in thought. He didn't seem too
worried about dying. I guess when you're his age and have a long gray
beard you get reconciled to the prospect. But I was young, and frankly I
didn't like the idea at all.
"I think I know a way," the little old man said finally, "but it will seem
like madness. Probably it is. It's never been tried. It may never work."
I seized him by the lapels. "Any way is better than none. I'd rather die
trying than sitting down moping my life away. Tell it to me."
"You won't laugh? You will take whatever I say seriously?" the little old
man asked anxiously.
I saw he didn't want to die the object of scorn, and I saw also that he
must have something pretty odd up his sleeve. "No," I answered, "you
won't hear a peep out of me."
"Then," said the old man, "if you can prepare yourself, you could walk
out through the rocks."

In spite of my promise, I gasped. But then I squelched myself and

thought that if I was with a lunatic, I might as well make the most of it.
He was now the other half of my universe and so standards had changed.
Facing death, any straw will do.
"Proceed," I said. "Explain further."
"Rocks," said the little old man—I guess he must have been a scientist of
some sort—"and all other matter are composed of nothing mainly, with a
little vibration thrown in."
I kept my mouth shut. I wasn't going to say anything to the contrary even
if he claimed black was white.
"Matter," he went on, "is composed entirely of atom. Atoms are broken
down to electrons and protons and their kin. They, in turn, appear to be
nothing but charges of electricity, charges of energy, not matter. So that
all matter is really just a manifestation of energy in a peculiar state of
stress."
I waited. This made sense. I began to recognize some of the things I had
learned years ago in high school physics.
"Between the vortices of energy which make up the building-blocks of
matter, there are comparatively vast stretches of just plain empty space.
Within the atom, almost all is vacuum. Between molecules, more
vacuum. In a so-called solid mass, it could be demonstrated that less than
a quadrillionth part of its mass has any reality and that only in the form
of disturbances of energy. And that figure is grossly exaggerated."
I waited. This was still making sense. And anyway, when you are
hopelessly trapped there is no sense in being impatient.
"If," went on the professor, "you understand this and project the picture
of it in your mind, you can mentally resolve all things into swirls of
nothingness, into less than air. If you can do so, you can attain complete
control over your own body—for we alone are able to control our own
masses by means of will.
"And if you can picture these masses of rock as pools of nothing and
yourself as the same, you can pass yourself through these rocks as a
whiff of smoke in air. You can revisualize yourself as solid outside this
trapping pile."
I thought about it. Wild it was and yet based on real reasoning.
"If you will give your mind to me, let me hypnotize you with your
cooperation, I think I can cause that to happen. You will then pass
through the rocks and appear outside. Then you will send for me," he
said.
I thought that over. "Why don't you do it yourself?" I asked.
"I am old and it is better done with an outside subject. Do not forget that
this has never been done."
"Okay. Start," I said, suddenly making up my mind. I didn't want to die
and I would do anything, however wild, to avoid it. When one sits alone
in darkness beneath a ruined house and knows that there is no hope, a
decision like this comes normally.
All is logical according to the conditions given.
I gave him my flashlight and he shone it in my eyes. Then he started
weaving it and repeating what he had said about atoms and electrons and
masses of nothing.
I watched him fascinated, and I thought of little whirlpools in empty
black space. I saw flashing ripples on a void. I saw lone lights untended
in nothingness and reflected from nothing. And I saw that they were
glowing from nothing. Light, just light.
I saw a solitary mote pursuing an endless track across a vast area that
was utter abyss.
Gradually the flashlight seemed to flicker and die. I felt wavy and
mistlike. I understood the meaning of matter and I saw indeed that matter
has very little real existence.
I felt that I was upon my feet, and they were long columns of
imagination having no reality save for endless electric foam.
I felt myself moving forward and I felt other disturbances passing
between me and around me and through me.
Then I saw that scenes were passing before my vision and the globules
of vacua that were my eyes seemed to register as they passed through
other globules of vacua.
I saw what seemed like a tiny planet spinning on its axis, while a strange
blue sun shone down and a dozen other planets swirled.
I saw a figure indescribable, mounted upon a thing incredible, pursuing
the unknowable across a vast and meaningless place.
I saw dozens of things like this—none of which can be described. Once I
saw a large machine with churning arms and it was all bubbly and yet
hard and mechanical.
All about me moved a great current and a wave of feelingless substance.
Then I felt a beating of forces upon me, I felt a hammering at me and I
felt a pressure pushing upon the whirling, imaginary pools of my being
and a curious coldness setting in.

I shivered and looked around. I was naked in the middle of the street; the
stars were out and the drone of airplanes audible. People were running
up and down and a hose was playing upon the front of a burning
building. The wardens were digging in some ruins with crowbars and
shovels.
A man came running up to me and threw a blanket over my trembling
shoulders.
"Where'd you come from? Bomb blow your clothes off? It happens."
I pointed to the pile of bricks and junk that marked my house.
"There's a man buried in those ruins, but he's alive," I said. "Just trapped.
You'll have to dig him out."
The warden blew his whistle and out of the turmoil three other men came
with picks and equipment and began to dig.
But it was two days before they finally got to him—and by that time he
was dead.
 *** END OF THE PROJECT GUTENBERG EBOOK NOTHING ***

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